A jumbo loan is a mortgage that has a loan amount that is greater than the limit set by the Federal National Mortgage Association (FNMA) or Freddie Mac.
Since the onset of the pandemic, the housing markets have had a remarkable ride to the upside, thanks to a surplus in demand. And combined with rising mortgage rates across the country, homes are getting more expensive for everyday folks, especially in California. As a result, you need to be well aware of your options when shopping around for your future home loan.
You properly don’t realize it, but there are many different types of mortgages that you can choose from depending on your situation. These consist of the following:
However, in this article, we will be focusing on jumbo loans and conforming loans. Note that some sites argue conforming loans differ from conventional loans. To understand this, you just need to remember while all conforming loans are conventional, not all conventional loans qualify as conforming. For simplicity, we’ll use these phrases interchangeably.
So, what is a jumbo loan? As the name implies, jumbo means very large, as this category of mortgage involves loans that surpass the limit of a conforming loan, which we will discuss in more detail later on.
Jumbo loans are typically sought by well-off home buyers, who tend to look for luxury properties that require high-balance loans. When the conforming loan limit is not enough to cover an expensive home in high-cost areas, mortgage lenders will have to offer borrowers the California jumbo loan option. For instance, if you live in competitive local housing markets, such as Orange County, California, then you most likely have to apply for this kind of mortgage since home values in these places have gone through the roof. It sounds scary, but it is really just a different type of loan that has higher standards for the borrower compared to the traditional conforming loan of 30 years.
Now, to know which mortgage loan is classified as a jumbo loan, you need to be aware of the California conforming loan limits. The Federal Housing Finance Agency, or FHFA for short, changes the traditional loan limit every year based on the nation’s average housing price fluctuation. In other words, when median home prices across the U.S. start to increase, you can expect the limit to go up also.
For example, as the median housing price jumped from $337,500 to $548,250 between 2020 and 2021, according to data from the St. Louis Fed, conforming limits rose from $548,250 to $647,200. And the latter limit will apply for a good part of 2022, including most California counties.
Nonetheless, there is also an exception to the conforming limit. The FHFA allows the ceiling loan cap to extend to $970,800 if too many homes in the area exceed the baseline limit, as this is the case for counties along the California Coast and San Francisco Bay Area.
In essence, any mortgage exceeding that limit, which is either $647,200 or $970,800 depending on the local region, can be classified as a jumbo loan.
Although you undoubtedly have seen the pandemic turn friends’ and families’ lives upside down, it has also been a blessing for the real estate market. When working from home became a trend, some areas saw an influx of new home buyers, pushing property values to skyrocket. And for the Bear Flag State, these areas included Los Angeles, San Francisco, San Jose, San Diego, and Anaheim.
However, despite having conventional loan limits raised to the maximum allowed amount, home prices in many California counties have risen so much that makes the limit increase seems negligible. The National Association of Realtors cited that the median home value in high-cost counties like San Francisco was $1,287,030 in early 2022. So even if the limit was $980,800, you still would have to shell out a 25% down payment, instead of a typical 20%, to qualify for a conforming loan.
Before you apply for a jumbo loan for your dream home in cities like Beverly Hills, you should be familiar with the criteria against which banks and mortgage lenders use to assess your eligibility. Generally, the qualifications have stricter requirements and are more rigorous, and involve more documentation than conventional loans.
First of all, the credit bureau Experian explains that applicants need to have a stellar credit score to qualify for a jumbo mortgage, which is in the range of 700 and above. (this is a higher credit score than a conventional loan) In addition, banks will examine your debt-to-income ratio (DTI), calculated by dividing your monthly debt payment (credit cards or other types of loans) by your income before taxes. Lenders typically want to see the DTI ratio to be under 43%, preferably closer to 36%.
Other conditions include, but are not necessarily limited to:
All of these conditions are to derisk the lender in case of the loan going into default. Those reasons alone are why it is extremely important to shop your mortgage around before you settle on a lender. Because jumbo loans are not insured by the same groups as conventional loans, there is more leeway for the requirements so each lender you go to can have a different set of requirements. Because of a more stringent requirement compared to nonconforming mortgages, a jumbo loan is usually appropriate for high-income earners, who make around $250,000 to $500,000 annually. That doesn't mean that you can't get one if you earn less, but you are less of a candidate at lower income levels.
This part might be a bit wordy and involves basic information on the macroeconomic situation in the U.S. But it is advantageous knowledge for you to know, and we will keep the flow straightforward and easy to follow.
Historically, mortgage rates for a jumbo loan were higher than conventional loan rates. However, the spread, or the difference between the two rates, is getting smaller. This is partly due to the U.S. central bank employing higher interest rates to fight against inflation, causing the rate for conventional mortgages to rise faster. And because the criteria for applying for a jumbo loan is more demanding, banks might consider the loan less risky, hence a lower interest rate.
Furthermore, since interest rates have always been a complicated matter for regular individuals, try to use a mortgage rate calculator or seek professional help to crunch the number carefully. Let’s use an example that applies real rates drawing from the USBank site to demonstrate the effect of mortgage rates on your monthly expense.
Suppose a wealthy customer is eager to buy a $1.3 million single-family home in San Mateo County, California. While the conventional 30-year fixed rate stays at 6.7%, that figure is 5.8% for a jumbo mortgage as of October 7. A calculation using those numbers will give us monthly payments of roughly $6,200 and $6,100 for conventional and jumbo mortgages, respectively.
The key thing to keep in mind here is that although the spread between the two mortgage expenses is minimal, the down payment is about $360,000 (25%) for the conventional loan and $260,000 (20%) for the jumbo loan, based on the calculation.
A common conception is that the higher the down payment, the lower the monthly mortgage expense. In this case, however, it is a bit counterintuitive. Even though the monthly payments between the two scenarios only have a small difference, the gap between the two down payments is significant. All in all, this hypothetical situation shows that you should always do your math thoroughly and select mortgage rates appropriately before buying a home.
Mortgages are not only an expense, but you can also take advantage of them in the form of tax deductions. Monthly mortgage expenses are tax deductible in any given year, but there is a limit to it. Specifically, because of the passage of the Tax Cuts and Jobs Act, homeowners can deduct mortgage interest on up to $1 million in debt if the home was purchased before December 15, 2017. On the other hand, if the deal happens after that date, only interests on up to $750,000 are eligible for deductions.
The reason why a jumbo mortgage loan requires a more stringent qualification for applicants is that it is not insured by Fannie Mae and Freddie Mac.
While the two names might sound like twin brothers, both are creative acronyms for two well-known mortgage companies. Fannie Mae, also known as the Federal National Mortgage Association, and Freddie Mac, aka the Federal Home Loan Mortgage Corp, are two quasi-government agencies. This means these agencies are privately owned but operate under the purview of the government. Fannie Mae and Freddie Mac’s primary purpose is to buy mortgage loans issued by mortgage lenders and commercial banks on a secondary market. However, the agencies only insure conforming loans, not jumbo mortgages. That is, lenders won’t be able to sell jumbo loans to these mortgage institutions.
In short, for you to be able to identify jumbo loans, you just need to know the maximum conforming loan limit. Every loan that surpasses that limit is considered a jumbo mortgage. The good news is that you don’t have to memorize the actual number for the limit, as it differs based on the county in which you live. So call up your mortgage lenders and ask them about the two loans, as well as the interest rates for each type of loan. This way, you will know what your options are and which is the better choice for your future home.